Best Of Breed: A Comeback For American Strategic Metals?

by: Real Assets Investment Research

Among casual observers, there seems to be a rough perception that the U.S. exhausted the bulk of its mineral deposits during its rapid phase of industrial growth and is now buying what it needs from countries like China out of sheer necessity. However, this is far from the reality of the situation. Chinese producers flooded the market with minerals such as rare earths, tungsten and manganese, pricing out domestic suppliers and causing many of them to shut down. Since 2009, China has phased down production creating opportunities for domestic suppliers to get back in the game. While politicians are perpetually competing to make the most breathless proclamations about reclaiming overseas jobs, the lack of self-sufficiency in minerals is hardly a hot topic during election season.

In this context, it was nice to hear Jack Lifton give an impassioned monologue on the subject as the keynote speaker of Octobers Best of Breed Natural Resource Conference, an event hosted by resource-oriented merchant bank Murdock Capital. Lifton, founder of Technology Metals Research and one of the field's most respected voices, highlighted not only the importance of maintaining a domestic supply of industrial metals but also the need to preserve institutional memory within American mining. Without "continuity of engineering," we would face severe setbacks in regenerating America's industrial resource base. While the dramatic tenor of Mr. Lifton's speech was certainly warranted given foreign dominance in vital niche minerals, it is encouraging to note that there remain many interesting companies in the American mining space. Said Murdock's president Tom Dean, "Number 14 in Murdock Capital's Natural Resources Symposium once again demonstrated that there are solid companies with highly attractive fundamentals seeking to tell their value proposition to an influential and highly motivated audience." The focus of the conference was not limited to American strategic metals, but there were three such outfits on the agenda with compelling projects.

Perhaps the most established operation presenting was Duluth Metals (OTCPK:DULMF), a Minnesota-based mining outfit that has attracted investors' attention based on the strength of its Twin Metals deposit. The investment opportunity was described as "Asset Backed," meaning that the physical value of metals contained in the property are enough to justify the market capitalization of shares outstanding. After finding geological continuity with an adjacent deposit, Duluth acquired Franconia Resources in a $76 Million transaction completed in March of 2011. Duluth's original properties were significant enough to put them among the top mines in the world in overall tonnage of nickel and copper deposits, but the blockbuster transaction truly enhanced the scope of their operations.

According to the company's most recent NI 43-101, Twin Metals contains indicated resources of 8 billion pounds of copper, 2.5 billion pounds of nickel, 3.2 million ounces of platinum and 7.2 million ounces of palladium. The project, described by some as a proposed "underground city" is a massive undertaking with an appropriately large-cap partner, namely Antofagasta plc (OTC:ANFGF), an FTSE 100 Chilean-based mining company with a market cap of $20 billion. The company, which is set to reach production of 700,000 tons of copper and 9,200 tons of molybdenum this year, brings solid expertise and capital support to the Twin Metals project.

The platinum and palladium deposits therein are particularly interesting in a global supply context. The Indicated and Inferred resources would make Twin Metals the largest deposit of these metals outside South Africa, whose production of Platinum Group Metals (PGMs) was down 21% in Q1 and Q2 of this year. America imports 88% of its platinum and 56% of its palladium, making increased domestic supply a key priority. According to the U.S. Gelogical Survey, which also produced the figures above, there are only two primary producing PGM mines in the United States, both located in Montana.

Nickel and copper are industrial minerals that generally track the performance of overall economic health. Prices for both lost a high degree of value in 2007 and 2008 and have yet to reach those highs. Both are also significantly dependent on Chinese industrial demand, a tendency which has undermined market confidence in many industrial metals. That said, the sheer size of the deposits would give Duluth a much better market share than most inaugural producers. Furthermore, production is still a few years down the road, at which point current price trends may well be irrelevant. The project economics of the Duluth Complex have been given favorable assessments by the geologists in the 43-101 and analysts at CIBC. The location of reliable nearby infrastructure and a long history of mining in the jurisdiction contributes to lower capex costs as well. High-grade, low-cost producers are always in the best position to weather price storms and Duluth seems to be in a good position on both counts.

It should be noted that permitting will be a pesky issue. I am not suggesting that Duluth will fail to gain the proper licenses in due course, but projects of this size always attract attention from local policymakers and the EPA. As such, the process may take longer than many investors would hope. It is likely for this reason that a world-class deposit is only producing "asset-backed" share value.

Another company presenting has already found a wealth of political support for its flagship Bokan Mountain project in the southwest tip of Alaska, namely UCore Rare Metals (OTCQX:UURAF). The Department of Defense recently announced it would undertake a metallurgical and mineralogical study, in conjunction with UCore, of the aforementioned property. Bokan Mountain has the largest 43-101 compliant Heavy Rare Earth deposit in North America. This is in contrast to the more common light rare earths mined by other American companies in the sector such as Molycorp.

Another advantage that UCore has over its domestic rare earth peers is location in Alaska. Long ranked as one of the most favorable mining jurisdictions in the world. The state legislature passed a resolution in 2010 to take any and all legal measures to expedite the permitting process for the Bokan Mountain project. The language of the bill possesses urgency and conviction worthy of Lifton's conference address. "[D]ysprosium and terbium are among the scarcest, most valuable, and sought after rare earth metals needed for green technology and military applications," the legislator notes, grimly elaborating that "a future in which manufacturing of wind turbines, solar panels, advanced batteries, and geothermal steam turbines are produced only outside of the United States poses a risk to the country." Perhaps more tellingly, the resolution's authors noted that "current economic opportunities on Prince of Wales Island and throughout Alaska have significantly decreased." Mining in Alaska, a $15 billion annual business, accounts for over 30% of the state's economic output, meaning that aside any concerns about the strategic importance of domestic rare earths production, the mining sector is a simple necessity to generate employment and development in the state.

It is for this reason that Governor Sean Parnell wrote a letter to President Obama in 2011 requesting additional funding and support for Bokan Mountain's rare earths project. And needless to say, those of us who have in the past underestimated the political cache of our northwestern-most state's governorship are not likely to do so again anytime soon.

In addition to the jurisdiction, the terrain and physical location add value to the project as well. Located in the temperate zone of the Prince of Wales Island, UCore gets the rare double whammy of favorable weather and Alaskan political support. In addition, Bokan Mountain is the only heavy rare earth project in the world with immediate deepwater access. Combined with the leftover power and transportation infrastructure from previous mining projects, CEO Jim McKenzie predicts the company will be able to ship unprocessed ore at a cost of well under a dollar per ton. With China cutting supply of HREE's, Bokan Mountain is shaping up to be a key part of America's industrial mineral base going forward.

That said, there remain key risks. The project is far from actual production and UCore is still in the process of developing a solid plan to extract the mineral deposits in an economical fashion. And while UCore owns a number of other intriguing properties, success of the company is largely contingent on Bokan Mountain fulfilling a key part of its potential. While subject to those and the same risks as any exploratory mining company, UCore boasts at least some buffer of government backing during the high capex zero revenue portion of pre-production activities

Another company present was American Vanadium (OTC:RMRCF), which Real Assets Investment Research's Daniel Fridson wrote about over the summer. Further developing the only advanced Vanadium project in the U.S. at Gibellini Hill, the company has successfully sold a $2 million private placement since the article's publication in August. With increasing public enthusiasm for vanadium flow batteries, the company has seen a slight shift in its end-user strategy toward energy storage rather than as an essential component High-Strength Low-Alloy Steel, which drove a spike in vanadium prices almost a decade ago. This is a positive development for the company's stability, as concerns about steel demand have negatively impacted all sorts of inputs in steel production, most notably iron ore. This trend should continue and diversification of end uses can only be good news for the company. It should be noted that the company has yet to secure a long-term off-take partner and vanadium prices remain subject to steel demand risk, but talks should become more favorable and serious as vanadium flow batteries continue to generate interest.

Indeed, it seems that the capability to extract, refine and produce essential industrial and strategic minerals in the U.S. is below optimum capacity but remains intact. The expected success of these three key projects should bolster further production and increase domestic interest from both investors and policymakers. If any vestiges of the lumbering bureaucracy of government have caught on to the importance and profitability of such enterprises, it is undoubtedly a good sign. As the three companies prepare for production, they stand as intriguing long-term value plays for the risk tolerant investor.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.